Step-Up in Basis and Inherited Property Taxes

The step-up in basis is arguably the single most valuable tax benefit in the inheritance process. It can save heirs tens or even hundreds of thousands of dollars in capital gains tax. Yet most families have never heard of it.

What Is Basis?

In tax terms, 'basis' is your starting point for calculating capital gains. When you sell an asset, you pay tax on the difference between the sale price and your basis. For assets you bought yourself, your basis is what you paid for them (plus improvements, in the case of real estate).

Example: You buy stock for $10,000. You sell it for $50,000. Your capital gain is $40,000, and you pay tax on that $40,000.

What the Step-Up Does

When you inherit an asset, your basis is 'stepped up' to the fair market value on the date of the deceased's death — not what the deceased originally paid. This eliminates all the unrealized capital gains that accumulated during the deceased's lifetime.

Example: Your parent bought a house in 1980 for $80,000. When they die, it's worth $500,000. Your stepped-up basis is $500,000. If you sell it for $500,000, your capital gain is zero. You owe no capital gains tax.

Without the step-up, you would inherit the original $80,000 basis and owe tax on $420,000 of gain — potentially over $100,000 in federal and state taxes.

What Assets Get the Step-Up?

• +Real estate (primary homes, rental properties, land)
• +Stocks, bonds, and mutual funds in taxable accounts
• +Business interests
• +Personal property (art, jewelry, collectibles)
• +Essentially all capital assets that pass through the estate

What Does NOT Get the Step-Up?

• +Retirement accounts (401k, traditional IRA) — these are taxed as ordinary income when withdrawn, not as capital gains. No step-up applies. Inherited Roth IRAs are generally tax-free on withdrawal but still do not receive a step-up in basis (it's not needed since qualified withdrawals are already tax-free).
• +Assets in irrevocable trusts — depends on the trust structure. Some irrevocable trusts do receive a step-up; others do not.
• +Gifts made during life — if your parent gifts you the house while alive, you get their original basis (carryover basis), NOT a step-up. This is why gifting appreciated assets before death is usually a tax mistake.
• +Income in respect of a decedent (IRD) — things like unpaid salary, annuity payments, and installment sale receivables.

Community Property Bonus

In community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin — Alaska also offers an opt-in community property system), both halves of community property get a stepped-up basis when one spouse dies — not just the deceased's half. This means a surviving spouse in a community property state gets a full step-up on the entire home, even though they still own their half.

This is a significant advantage over common-law states, where only the deceased's share gets the step-up.

Planning Implications

• +Don't gift appreciated assets to heirs while alive — the recipient gets carryover basis instead of a step-up.
• +If you plan to sell an inherited asset, do it soon after death while the FMV is close to the stepped-up basis. Waiting years and selling at a higher price means paying capital gains on the post-death appreciation.
• +Get a date-of-death appraisal for inherited real estate. You'll need this to establish your basis if you sell later.
• +For high-value estates, the step-up in basis must be weighed against potential estate taxes. The step-up saves on income/capital gains tax, but the asset's full value counts toward the federal estate tax.